CHWY | Strong 1Q In Tough Ecom Market

Best Idea Long CHWY delivered a great Q vs expectations.  Slight revenue beat with strong gross margins and slightly lower than expected SG&A, driving Adjusted EBITDA well ahead of consensus at $61mm vs $2mm expected.  The company put up more EBITDA this Q than was expected for the year by the street.  Management simply held the full year guide including the breakeven to 1% EBITDA margin while straddling the street 2Q revs, smart given the pressure on the stock, no reason to push consensus higher yet, just keep beating.  Gross margin strength came from pricing actions put in place late last year and management of supply chain cost pressure and the promotional cadence.  It’s a bit hard to celebrate that beat, since, let’s face it, anything in ecommerce has been ugly over the last 6 months.  There is definitely spending reversion happening with the combo of service spending returning, inflation pressuring the consumer, and some shift back to brick-and-mortar shopping.  Meanwhile Quad4 has crushed multiples across the space.  CHWY and AMZN have been our longs in ecommerce as both have seen margins lower back in 2021 as they invest to setup the next leg of growth alongside labor and supply chain pressures.  We also like that these are ecommerce leaders with less discretionary and stickier revenues, particularly CHWY.  Autoship customer sales were up 19%, now 72.2% of sales.  There isn’t going to be much, if any, reversion in that base.  Customer growth of course has slowed like much of ecommerce as non-core customers churned off, LTM active customers fell slightly this Q to 20.6mm, but spending per active customer continues to rise, up 15% yy on a LTM basis.  CHWY was able to deliver one of the best growth rates in ecommerce once again growing 14% while many other larger scale ecom players sales were down in 1Q.  When we elevated this name on our long list in December, our view was that we would see accelerating trends in the spring, guidance implies revenue rate of change is steady in 2Q and improving into 2H.   Margin compares ease, though management did say there is some potential need for further price adjustments on near term inflation.  Still, it looks to us like there is upside to both revenue and margin guidance and the insurance offering being done in partnership with Trupanion starts within weeks while assumed to have no impact as it relates to guidance.  The pet category will continue to grow, it won’t see an air pocket in demand like other consumer goods categories.  Online will continue to take wallet share, and CHWY will continue to gain share in pet.  Looking at valuation, we think this could be a 3-5% EBITDA margin business over a Tail duration and looking out longer we think it can scale to 7-9% margins.  A fair value today is likely around $35 to $40, then as the EBITDA unlocks, we think we could see a stock in the $50 to $75 range in 12-18 months.  It could be a long time before we see peaky multiples across consumer growth again, as the complete destruction of equity value over the last couple quarters will make investors hesitant to go the EV/sales route.  So maybe the $100+ CHWY stock is on hold for now, but we see real earnings and cash flow potential here in combination with high revenue and profit growth as one of the better ecommerce platforms out there.